With interest rates in general still so low, fixed-rate home equity loans can be extraordinarily inexpensive forms of borrowing. Indeed, unless you have a rich and generous relation, you probably won't find a cheaper loan, short of a full mortgage refinance. Better yet, it's relatively easy to get approved for a home equity loan, though there are still some hurdles to clear. Different lenders use different criteria in making decisions, but here are five questions you should probably ask yourself before making an application:
1. Do I Have Enough Equity?
As a rule, lenders prefer that the total "secured" borrowing (the current balance on your existing mortgage, plus your new and any existing home equity loans) on your home doesn't exceed 75 to 80 percent of its current market value. To make sure you're being realistic, it's a good idea to do a bit of online research yourself to guesstimate that value before you make an application. However, the lender will send an independent appraiser out to your home before the loan is finalized, so there's no point kidding yourself.
Let's look at an example. Suppose your home is currently worth $200,000 and the balance on your existing mortgage this morning was $130,000. Assuming you qualify in other respects, most lenders would be happy for you to borrow a total of $150,000 to $160,000 against the home (75 to 80 percent of $200,000), less your existing mortgage of $130,000. So the maximum value of your fixed-rate home equity loan should come within the range of $20,000-$30,000. Of course, you don't have to borrow that much unless you want to – although ...
2. Do I Want to Borrow Enough?
Although the hassle and paperwork involved in applying for one of these is generally less than for a main mortgage, there is still plenty of admin to go through and some expense to be incurred. This means it's rarely worth your or your lender's while to set up a home equity loan for a small amount.
Some lenders place floors on the amounts they're prepared to lend to home equity borrowers of $20,000 or $25,000. You might find one prepared to offer less, but certainly don't expect to go below $10,000.
3. Is My Credit Score Good Enough?
You can have a surprisingly low credit score and still get approved for a home equity loan. Indeed, some with scores as low as 620 get approved. That's not because lenders have suddenly become altruistic: It's because they know they can foreclose on your home if you get into trouble.
A lowish score may not be a bar to approval, but it can play a big part in making your payments less affordable. FICO, the company behind the most widely used scoring technologies, reckons someone with a great score of 740-850 could recently have paid a rate as low as 4.73 percent on a 15-year, $50,000 home equity loan (rates change daily so check the latest), which would see monthly payments of $388. Someone wanting the same loan who has a score of 620 might be offered a rate of 10.73 percent and monthly payments of $560. Over the 180 months of a 15-year term, that difference would see the less creditworthy borrower pay nearly $31,000 more.
If you want to know your current score, continue to monitor it each month and receive advice on how to improve it, you can use the LendingTree credit score service, which is entirely free. In addition, you are by law entitled to receive a copy of your credit reports free each year, and you can request yours from a website operated by the Big Three credit bureaus.
4. Are My Finances in Good Enough Shape?
More responsible lenders wish to make sure borrowers can afford the monthly payments on their new fixed-rate home equity loans. So they're going to want to check your income and outgoings. Some are more careful than others, but you may be asked to show that:
- Payments on your existing and new debts (your existing mortgage and new home equity loan, plus your credit cards, student, personal and auto loans or leases and other debts) don't represent a bigger proportion of your regular gross monthly income than a particular threshold, sometimes 43 percent. If you undertake to use your new loan to consolidate (pay down) other debts, that will usually be taken into account.
- Your employment is stable and you can prove the claims you make about your salary and other income.
- You understand how your new home equity loan works within your longer-term financial strategy. Don't worry. It's not a test! See "8 Things to Know Before Getting a Home Equity Loan" to learn what you need to know.
Some, but by no means all, lenders prefer you to secure your loan on your main residence rather than an investment or vacation property. If that's an issue for you, shop around for one without that rule.
5. Am I Set to Go?
If you're sure a home equity loan is right for you, you might want to apply for one as soon as possible. At the time of writing, interest rates for these are still incredibly low. And, assuming rates go up soon, as many expect, one with a fixed rate could see you saving substantial amounts over the lifetime of the loan, compared with one you apply for later.
Start now by calculating your available equity. Then go on to compare rates, get quotes, submit your application and start to pull together the paperwork you might need to support it.